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Buy, Sell, or Hold: Star Scientific

Do the considerable risks outweigh the possible benefits?

Sporting just one star (out of a possible five) in our CAPS community, and with investors there roughly evenly split between bearishness and bullishness on the company, you might think that Star Scientific(Nasdaq: CIGX) is a stock best avoided. You're may be right, but let's not be hasty. Let's take a closer look at why you might want to buy, sell, or hold Star Scientific -- in the process taking a look at some other tobacco concerns you might consider.

As its clever ticker symbol implies, Star Scientific specializes in smokeless tobacco products and its technology purports to reduce the harmful effects of tobacco. For many of those trying to quit smoking, it's of great interest.

BuyOne reason to buy the company is that, especially in America, smoking is slowly falling out of favor. This hurts traditional cigarette purveyors, while boosting the appeal of Star Scientific's offerings. Between 1965 and 2007, the percentage of Americans smoking a pack or more a day dropped from 56% to 7%. Those smoking between 10 and 19 cigarettes per day fell from 11% to 5%.

There is a multitude of factors affecting this, including health concerns and rising taxes on cigarettes that have driven prices up sharply over the years. Obviously, tobacco companies have been hurt by the decline in smoking, and are eager to share that data. Reynolds American(NYSE: RAI) points out, for example, that the average cost of a pack of cigarettes has more than doubled since 1998, rising from $2.09 to $5.86. The company also notes: "Since 1998, governments at all levels have collected more than $400 BILLION in cigarette taxes and payments from smokers." Reynolds' revenue has been roughly flat over the past few years, as it struggles to overcome a shrinking domestic consumer base amid rising prices.

Altria(NYSE: MO), the domestic tobacco giant with brands such as Marlboro, has many investors fearing that its best years are behind it, and thinking that its global counterpart, Philip Morris International(NYSE: PM), holds more promise because tobacco consumption is growing faster abroad. Indeed, my colleague Sean Williams calls Altria "a shell of the company it once was." Among other benefits, Philip Morris is better able to avoid the kind of litigation costs that plague domestic operators. Two lawsuits alone led to a $119 million fourth-quarter charge for Altria.

Some are bullish on the company because of its tobacco-derived dietary supplement, Anatabloc, which has been outselling Star Scientific's dissolvable tobacco products.

SellAlas, even in this difficult environment for traditional tobacco companies, Star Scientific isn't thriving. It has operated at a loss for nearly a decade now.

Its Anatabloc supplement, meanwhile, may not be the white in shining armor some expect it to be. My colleague Dan Newman has noted that management has been given an incentive to sell or license this technology to others, instead of aiming for strong internal growth.

In addition, the company faces competition. Altria, Reynolds, and others also offer smokeless tobacco products -- and have far deeper pockets with which to fund research and development and marketing.

If that's not enough, there's dilution. The company has kept itself afloat partly through the repeated issuance of additional shares of stock. Each new share reduces the ownership stake of existing shares, though, and this is a wealth-destroying move for shareholders. (Star Scientific isn't the only tobacco company making poor decisions -- Vector Group(NYSE: VGR) has been taking on debt in order to maintain a 9% dividend, while paying out more than it earns!)

HoldWhy might you hold shares of Star Scientific? Well, if you think it's one of the most promising stocks on the market, then by all means hang on. But failing that, consider selling. You should always have your money invested in your best ideas. Why have any money in your 246th best idea, when you can move that money into one of your top-10 ideas?

The verdictWhen it comes to Star Scientific, the risks seem to far outweigh the potential rewards. I'm steering clear, and you might want to, as well. You can do better.

While Star Scientific may be a sell, I most certainly have a stock that we at The Motley Fool think is a buy. We are so bullish on it, we've named it "The Motley Fool's Top Stock for 2012". Where Star Scientific's future is marred with uncertainty, this emerging market powerhouse looks like it's got clear skies ahead. We've compiled a free report for you to uncover this stock today. If you're interested you can click here to access it now.

Author

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter... Follow @SelenaMaranjian